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Balfour Beatty - Margins beginning to build

Nicholas Hyett | 16 August 2017 | A A A
Balfour Beatty - Margins beginning to build

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Balfour Beatty plc Ordinary 50p

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Balfour Beatty reported an underlying operating profit of £39m for the first half (2016: £11m). The interim dividend rose 33% to 1.2p per share.

The shares rose 4.5% following the announcement.

Our View

CEO Leo Quinn began his career at Balfour Beatty (BBY) and went on to restore De La Rue and Qinetiq to something approaching good health, before returning many years later to find his alma mater in dire need of the same treatment.

Essentially Mr Quinn diagnosed a business that sought to hide underlying difficulties by boosting revenue through M&A and accepted excessive risks by bidding for work at low margins. That left too many contracts that were destined to generate losses, plus a cost base full of duplications when acquired businesses had not been properly integrated.

The group has now completed the first phase of Mr Quinn's 'Build to Last' turnaround strategy, spending a painful two years weeding out underperforming contracts and slashing costs to put the core construction business back on an even footing. The next step is to return margins to something resembling the industry norm by 2018, as it becomes more selective in the contracts it undertakes.

Early signs are good, with both the support services and US construction businesses on course to deliver industry standard margins this year. UK construction remains a weak spot, but the group is confident of hitting the 2-3% margin target by the end of 2018. Phase three, building a premium into margins, doesn't begin until 2019 though - so there's some way to go yet!

Market conditions seem to be swinging in Balfour's favour, as governments on both sides of the Atlantic loosen the austerity purse strings to spend on infrastructure. However, construction is a cyclical business, and Balfour is very exposed to economic slowdowns or changes in government policy.

Consensus has earnings recovering over the next few years. Even so, analysts are not expecting a return to historic profit levels anytime soon, and on that basis, dividends are likely to be relatively modest for the foreseeable. Investors need to be playing a long game here, with a close eye on the global macro situation, for if that turns hostile, Mr Quinn really will have his work cut out.

Half Year Results

The significant improvement in profitability came despite revenues improving just 1% at constant exchange rates (CER) to £4.2bn. The value of the order book fell 6% at CER to £11.4bn.

Construction - Underlying operating profits of £24m (2016: -£54m), were driven by a return to profitability in the UK and good performance in the US. The order book in the division shrunk by 10% CER to £8.1bn (UK down 4%, US down 10% and Far East down 18%).

Support Services - Operating profits rose 45% to £16m, despite revenues falling 5%, as margins improved from 2% in H116 to 3.1%. The order book remained flat at £3.3bn.

Infrastructure Investments - Operating profits of £15m were lower than last year (2016: £70m), largely due to the lack of disposals in the half. The portfolio was valued at £1.235bn, up 1% on the year end.

Now in stage two of its Build to Last turnaround strategy, Balfour Beatty is confident of achieving industry standard margins across its operating businesses by the end of 2018. This requires managing historical contracts through to completion; reducing costs across the Group; and executing on the higher quality order book.

The group is on track to meet underlying profit expectations for this year.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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